Banking & Financial Services. White Paper. Enterprise Performance Management Driving Shareholder Value for Banks

Transcription

1 Bakig & Fiacial Services White Paper Eterprise Performace Maagemet Drivig Shareholder Value for Baks

2 About the Author Sridhar Sriivasa Sridhar Sriivasa is a Domai Cosultat with the Fiace ad Reportig practice withi the Bakig ad Fiacial Services (BFS) busiess uit at Tata Cosultacy Services (TCS). He is a Chartered Accoutat ad has more tha 20 years' experiece i cosultig ad fiace. Sridhar has achored several strategic projects for TCS' cliets spaig cosultig egagemets, process studies, ERP implemetatios, support for fiacial reportig, as well as fiacial modelig ad pricig, amog others.

3 Abstract Shareholder value is a key parameter with regard to the valuatio of a eterprise; it assumes greater promiece i today's dyamic ecoomic eviromet. This measure provides a clear, uambiguous quatificatio of a orgaizatio's value withi the framework of curret fiacial reportig stadards ad bakig regulatios. I spite of beig criticized for havig a arrow focus o fiacial goals, it helps the maagemet gai a aggregated view of the value of a bakig eterprise, ad uderstad it i all its fiacial facets profitability, capital, solvecy or liquidity, ad risks. As markets become competitive ad customers grow demadig, Chief Fiacial Officers (CFOs) across the bakig world eed to proactively participate i developig the orgaizatio's strategic roadmap, review busiess performace, as well as edorse its aual fiacial results. A CFO's resposibilities iclude decisio-makig related to the pricig of fiacial products, measuremet ad maagemet of liquidity, solvecy, iterest rate risks, fud trasfer pricig, ad credit loss provisioig, amog others. This paper examies the plaig ad decisio support systems that bakig CFOs require to improve busiess output, thereby ehacig shareholder value.

4 Cotets Itroductio 5 How Shareholder Value is Measured 5 What Impacts Shareholder Value of Baks 6 Eterprise Performace Maagemet is the Aswer 7 Desigig a Effective EPM System 7 Coclusio 9

5 Itroductio To avoid a fiacial debacle, ledig firms should adopt a coservative approach i sactioig credit, ad dissuade customers from assumig highly leveraged positios with respect to their fudig arragemets. However, over the last couple of decades, to make the most of a boomig ecoomy, baks had drifted from this guidig priciple to esure profitability. Competitive pressures therefore resulted i highly leveraged, low equity bakig etities. Uder the recessioary pressures of the recet past, such baks tried to de-leverage from teuous positios by sheddig assets or usig methods such as securitizatio. Fiacial etities, globally, had bee draw ito a web of trasactios, for example, of mortgage-based securities ad a host of related fiacial istrumets. As regulatios became stricter, ledig istitutios tured to short-term fudig sources, rather tha covetioal deposits, for these trasactios. Debt default ad liquidity cocers resulted i paic sales all across, which further led to a dowward spiral of asset prices, sikig profits, ad the geeral erosio of equity valuatios, across the globe. Post the fiacial crisis, baks put i coscious efforts to move back toward better capitalizatio, i part, also due to stiffer regulatory demads. However, they cotiue to struggle with cocers aroud low profitability ad their iability to sustai capital buffer to exted credit a critical eed for may growth-starved ecoomies. This has also resulted i a shift to ew busiess models for improved profitability ad sustaiable operatios. The focus ow is to miimize leveragig of equity ad adopt strategies that promote ivestmets with healthier RoIs, while icreasig shareholder value. As a result, the role of the bakig CFO has expaded to iclude the resposibility for makig recommedatios for orgaizatioal strategy ad evaluatig post-executio performace. I light of these developmets, baks eed to have strog mechaisms for eterprise performace maagemet (EPM). They eed efficiet EPM systems that provide holistic as well as graular views of the eterprise. CFOs ca use such systems to gai a deeper uderstadig of the bak s curret ad future fiacial valuatios, profitability, ad cash flows (both o ad off balace sheet), for better trasparecy ad improved capability to make future projectios. By eablig CFOs to actively participate i the strategic plaig ad forecastig process, ad allowig them to set target performace metrics ad recommed course correctios as ad whe required, these systems help i esurig the bak cosistetly creates shareholder value. How Shareholder Value is Measured As per fiacial literature, etity valuatios are doe o the basis of fiacial reportig stadards ad frameworks, ad the results are preseted i fiacial statemets. However, market volatilities over the last decade have chaged the perceptio of value, egieered ew busiess models, ad developed complex fiacial istrumets for risk maagemet. These chages have i tur triggered a eed for a reappraisal of stadards ad regulatios to classify ad measure the value of a eterprise. The mere valuatio of a eterprise s assets ad liabilities at a give poit of time does ot quite suffice to capture the value of a goig cocer. Idustry aalysts use several methods to measure ad forecast shareholder value based o covetioal market multiples. These iclude PE ratio, MBV approach, ad other evolutioary models aroud cash flow discoutig such as the divided growth model. The bakig idustry is susceptible to credit cycles ad loa defaults, therefore market 5

6 aticipatios based o ratios (like PE ad MBV) have limitatios ad ca lead to distortios i valuatio forecasts. Shareholder Value Added is aother measure calculated as the excess of a eterprise s Retur o Equity (RoE) over the shareholders expected Rate of Retur (RoR); it reflects the compay's efficiecy i utilizig ivestor moey. A bak s valuatio is best gauged ot oly with respect to preset itrisic valuatios o its books, but also its future cash flows expected o a goig cocer priciple. These future cash flows arise from o-balace sheet busiess (et iterest icome) ad off-balace sheet busiess (fee-based icomes like advisory work, commissios, asset maagemet, brokerage, ad so o). Operatig i a busiess eviromet that is ofte o the edge, ad survivig a regulatory framework that keeps gettig striget i respose, bakig orgaizatios are compelled to make cotiual assessmets of what creates value ad what erodes it. Techology ca help make these dyamic evaluatios ad simulate their impact o shareholder value, usig graular data, ecoomic, busiess, ad decisio variables, ad by embeddig domai isights ito related IT applicatios. Shareholder value reflects a orgaizatio's efficiecy i usig ivestor moey, resposibly ad profitably. Cotiual assessmet of how you fare o this parameter is therefore a busiess imperative. What Impacts Shareholder Value of Baks The C-suite's cocers aroud a bak's valuatio eed to be uderstood i the cotext of may iteral ad exteral factors. Exteral factors iclude the ecoomic eviromet i which the bak operates, fiacial positios of its peers, their ifluece o re-pricig products ad market share. Iteral factors iclude the curret state of its balace sheet, profitability of its lies of busiess, risks, ad the costraits or capacities of regulatory capital. Baks eed to strategize for ew busiess models. This ca imply a combiatio of low profitability with ew regulatory requiremets (for capital adequacy), portfolio sell-offs, re-pricig of existig busiess lies, o-core busiess divestmets, ad reductios i operatioal costs. I some cases, baks may move away from covetioal credit to more fee-based services to improve returs. Chage i busiess models have their implicatios o shareholder value i the medium to log term. Ever sice the crisis, may major Europea ad North America baks have udertake the 'repair' of their balace sheets by de-riskig ad de-leveragig their positios. Balace sheets stregtheed for regulatory capital however, imply carryig higher costs (a higher equity spread o bak loas), as well as lower retur o equity (ROE) ad retur o assets (RoA), compared to historical values. Lower profitability is reflective of cautious, coservative, low risk-retur activities, ad a carryover of past burdes i terms of No-Performig Assets (NPAs) i a sluggish ecoomy as well as high litigatio costs. BASEL III requiremets for LCR (Liquidity Coverage Ratio) ad Net Stable Fudig Requiremets (NSFR) will further udge baks toward liquid (low retur) assets. Chage i the regulatory eviromet has iflueced this balace sheet repair exercise, thereby impactig valuatios. Profitability or earigs are iflueced by ivestmet decisios that may lower Net Iterest Margis (NIMs). Decisios o re-pricig ad timig of deposits ad loas also iflueces iterest rates that i tur impact profits. Other factors iclude operatig efficiecy of baks (impacts techology decisios ad busiess models), iflatio 6

7 (impacts salary escalatios), ad restructurig exercises (which may imply higher cost-to-icome ratio). O the other had, improved asset quality ad capital ratios ecourage baks to icrease loa clietele ad promote growth. Restructurig of operatios ca improve profitability ad shareholder value i the log ru. Baks fid themselves i varyig circumstaces of recovery ad capital stregth proportios, amid busiess restructurig exercises for restoratio of capital or profitability, as well as hagovers of past debt ad litigatios. Further, curret ad future ecoomic factors may ifluece each other i evolvig coutry-specific ecoomic phases. Bakig CFOs therefore face multiple challeges, costraits, ad factors that ifluece each other, which i tur might result i a upward or dowward spiral i shareholder value. Eterprise Performace Maagemet is the Aswer Oce established o the basis of fiacial valuatios ad cash flows, the eterprise shareholder value ca be uderstood i terms of key fiacial metrics. These iclude profitability, operatig efficiecy, leverage, liquidity, ad capital adequacy. A bakig eterprise therefore requires a strog EPM system to accurately evaluate itself ad its etities the group, paret, subsidiaries, busiess lies, value ceters, ad braches. This requires EPM systems to have plaig, forecastig, budgetig, ad performace review capabilities that alig with the bak's objectives for ehacig shareholder value. The EPM system should also build i the flexibility for the bak to recast its plas ad forecasts if ecessary, cosiderig the busiess or ecoomic cycle it fids itself i. Desigig a Effective EPM System Ay eterprise system for evaluatio, tabulatio, aalysis, ad suggestio, is oly as good as the data ad process defiitios fed ito it. Hece, the primary requisite of a good EPM system for bakig istitutios is the access to accurate, curret eterprise data. This will esure the accuracy of projectios o profitability, cash flows, ad more. Key cosideratios while desigig a EPM system for baks are: Eterprise data: Graular eterprise data o deposits, loas, ivestmets, ad other fiacial istrumets could be related to curret balaces ad cotractual terms with regard to iterest rates ad maturity patters, cash flows expected from each istrumet, ad more. These data poits are used to calculate their summarized impact at a eterprise level for upcomig forecast periods. Macroecoomic idicators: Geography-specific macroecoomic idicators should be defied to assess the impact o projected fiacials, which should further be modeled i accordigly. These macro-ecoomic idicators iclude: Iterest rate yield curves applicable to forecasted periods Impact of iflatio o the yield curve ad associated effects o re-pricig decisios ad growth rate Ifluece of idicators like GDP o deposit, loa growth, ad ivestmet setimets The cojoit set of factors that idicate the stage of the credit cycle that the eterprise will be i a give period, ad related impact, for istace, o ledig activities ad o-performace allowaces for the period 7

8 Itrisic factors: Itrisic factors that ifluece bakig processes should be modeled ito the EPM system. These are: Factors that ifluece prepaymets of loas (like age ad teure) or make customers switch loas (for istace a chage from floatig to fixed rates) Decisios that ifluece deposits (for istace, their growth, shifts from oe type to aother) Trasfer pricig decisios that ifluece deposits ad loas (cosumer, corporate, iter-bak) Circumstaces that ifluece re-pricig decisios Risk factors ad key decisio variables: The EPM system must provide a mechaism to idetify risk factors ad key decisio variables to assess the impact o fiacial projectios. The mechaism should help baks: Idetify ad aggregate risks, categorized by their ature (for istace, credit, market, liquidity, operatioal, strategic, ad regulatory risks) Uderstad the impact of differet decisio variables (for istace, re-pricig, trasfer pricig, strategic growth factors, ad more) Factor i the impact of strategic iitiatives that ifluece market share, reveue, operatig costs, ad so o Idetify ad model i specific litigatio costs based o past behavior or future probability Model risk impacts o fiacials usig statistical distributios ad simulatio techiques Cotrols ad costraits: The EPM system should provide specific cotrols ad costraits withi which all projectios ca be made. These iclude: Factors that costrai or cotrol fiacial projectios (for example, asset liability maagemet (ALM) approaches or guidelies, cotrollig or limitig parameters idicated i a maagemet pla, loa-deposit ratio, liquidity coverage, fud stability, ad other boudig factors) Ability to predict ad set resource requiremets (for istace, resources ad fuds eeded to meet the bak's growth requiremets i lie with its strategic plas) Quatitative methods: The system should have simulative features, sceario buildig capabilities, ad optimizatio techiques. These iclude: The ability to simulate ad stress test projected fiacial statemets for positios, profitability, cash flows, ad more Capital optimizatio models to recocile regulatory capital with ecoomic capital ad provide metrics for efficiet ad optimized capital maagemet Dashboards to view the impact of chagig variables by way of 'what-if' aalyses or simulatio of performace idicators for all aspects of profitability, efficiecy, credit, liquidity, ad solvecy (like ROE, Risk-adjusted Retur O Capital (RAROC), NIM, (NIM Customer Spread (CS)%), CIR (Cost Icome Ratio),NSFR, LCR, ad others) 8

9 Data visibility: Holistic, dimesioal, pivotal, ad graular views of projectios ad actual results. These iclude: Fiacials ad relevat performace idicators classified by orgaizatioal dimesios: products, chaels, busiess lies, geographies, large customers, ad more A breakdow of the ROE ad RAROC to their elemetal compoets at the eterprise as well as the LoB level, after appropriate allocatio of capital ad profitability Usage of RAROC as a poiter to hurdle rates for chaels, LoBs, products, or importat customer relatioships Compatibility of budgets ad forecasts with fiacial statemets with regard to accoutig policies ad stadards, ad the ability to track all lie items of fiacial statemets, whether from a group cosolidated level or subsidiary level, to requisite detail i books Shareholder value ad its breakdow to all the parameters that ifluece it Coclusio Shareholder value is a pragmatic ad holistic measure to assess a bak's fiacial health. Performace maagemet systems for bakig istitutios eed to go beyod commo market multiples ad provide deeper isights ito future profitability ad cash flows, to uderstad ad predict shareholder value. EPM systems eed to have requisite aalytics capabilities to provide ample graularity regardig this vital parameter i terms of bakig metrics like profitability, efficiecy, credit, leverage, liquidity, ad capital adequacy. As a bak's shareholder value may grow or erode depedig o its macro-ecoomic eviromet, other tha its ow busiess model ad capital arragemets, the forecastig mechaism must tie ito, ad be relevat to the ecoomic cycle or phase i which the orgaizatio operates. The logic ad algorithms embedded i systems should also ecessarily provide the meas to simulate stress ad optimize fiacial forecasts while makig regulatory capital requiremets ecoomically viable. A covergece of digital solutios, aalytics, domai isights, kowledge of stadards ad regulatios, ad quatitative methods is eeded to calibrate ad drive shareholder value across the eterprise. 9

10 About TCS' Bakig ad Fiacial Services Busiess Uit With over four decades of experiece workig with the world's leadig baks ad fiacial istitutios, TCS offers a comprehesive portfolio of domai-focused processes, frameworks, ad solutios that empower orgaizatios to respod to market chages quickly, maage customer relatioships profitably, ad stay ahead of competitio. Our offerigs combie customizable solutio accelerators with expertise gaied from egagig with global baks, regulatory ad developmet istitutios, ad diversified ad specialty fiacial istitutios. TCS helps leadig orgaizatios achieve key operatioal ad strategic objectives across retail ad corporate bakig, capital markets, market ifrastructure, cards, risk maagemet, ad treasury TCS has bee raked #2 i the 2014 FiTech Rakigs Top 100 of global techology providers to the fiacial services idustry, by both - FiTech Forward (a collaboratio of America Baker ad BAI) ad IDC Fiacial Isights. TCS has also bee recogized as a 'Leader' ad a 'Star Performer' i Everest Group's 2014 PEAK Matrix reports for Bakig ad Capital Markets Applicatio Outsourcig (AO). Cotact For more iformatio about TCS' Bakig ad Fiacial Services Uit, visit: [email protected] Subscribe to TCS White Papers TCS.com RSS: Feedburer: About Tata Cosultacy Services (TCS) Tata Cosultacy Services is a IT services, cosultig ad busiess solutios orgaizatio that delivers real results to global busiess, esurig a level of certaity o other firm ca match. TCS offers a cosultig-led, itegrated portfolio of IT ad IT-eabled ifrastructure, egieerig ad assurace services. This is delivered through its uique Global Network Delivery ModelTM, recogized as the bechmark of excellece i software developmet. A part of the Tata Group, Idia s largest idustrial coglomerate, TCS has a global footprit ad is listed o the Natioal Stock Exchage ad Bombay Stock Exchage i Idia. IT Services Busiess Solutios Cosultig All cotet / iformatio preset here is the exclusive property of Tata Cosultacy Services Limited (TCS). The cotet / iformatio cotaied here is correct at the time of publishig. No material from here may be copied, modified, reproduced, republished, uploaded, trasmitted, posted or distributed i ay form without prior writte permissio from TCS. Uauthorized use of the cotet / iformatio appearig here may violate copyright, trademark ad other applicable laws, ad could result i crimial or civil pealties. Copyright 2015 Tata Cosultacy Services Limited TCS Desig Services I M I 07 I 15 For more iformatio, visit us at